Interest rates will be going higher.
Love it or hate it, one of the biggest drivers of the economic recovery and stock market rally over these last nine years has been the U.S. Federal Reserve. The institution embarked on innovative and unconventional strategies, including near-zero interest rates, to right the wrongs of the financial crisis and Great Recession. But now that unemployment is at historic lows and the economy is on the upswing, the days of historically low rates are over — the Fed inched rates higher five times in the last two years, and more increases are expected. Here are seven tactical exchange-traded funds to prepare your portfolio for a rising rate environment.
Schwab Short-Term U.S. Treasury ETF (ticker: SCHO)
If you don’t like the idea of getting burned by rising rates but still want to buy government bonds for either diversification or income, it may help to shorten the duration of your investments. Consider the SCHO ETF. This fund only buys bonds with a duration of one to three years. As such, the underlying assets don’t lose as much value if rates rise since they mature much faster. The yields are lower than in longer duration bonds, of course, but that’s the trade-off to avoid taking a hit on your principal value.
Current yield: 1.9 percent
Vanguard Short-Term Corporate Bond ETF (VCSH)
If you’d like to take on a little more risk to find a little more yield, then consider investing in corporate bonds instead of government bonds. The VCSH offers bonds with a duration of one to five years, primarily in highly-rated “investment grade” corporate debt. The U.S. Treasury is a near-certain investment while some businesses do indeed fail, so there’s a chance of higher volatility here. But with loans to mega-corporations Bank of America Corp. (BAC) and Anheuser-Busch InBev (BUD) among others, the likelihood of a severe downturn thanks to bond defaults is still very slim.
Current yield: 2.6 percent.
PowerShares LadderRite 0-5 Year Corporate Bond Portfolio (LDRI)
Another interesting twist on traditional bond investing is to use an ETF to “ladder” your bond portfolio. The investment objective is to buy a series of bonds across a variety of maturity dates to ensure you’re not taking the hit on your entire holdings; as the individual bonds mature, a new bond is purchased. This is a powerful technique because you risk next to zero loss of principal. After all, bonds only lose value if you sell them for less than you bought them — and holding to maturity means the fund managers never sell. Instead, this fund just passes on the distributions to you (less expenses, of course).
Current yield: 2.2 percent
Pimco ETF Trust (BOND)
Of course, one solution instead of worrying about shorter duration to hedge against higher interest rates is to simply put your trust in a tactical fund that moves money when it’s appropriate. That’s what BOND, the flagship bond ETF of megamanager Pimco, does. BOND changed strategy recently with a shift in managers in mid-2017, but the new mandate for income-focused performance instead of profit on bond trading is perfect for investors looking to limit risk amid rising rates. The fund holds a mix of investment-grade corporate bonds, junk bonds, government bonds and cash based on current conditions. There’s risk if managers get it wrong, but also the ability to be flexible as things change.
Current yield: 2.6 percent
Select Sector SPDR Financials ETF (XLF)
When rates rise, the companies that have a lot of cash reserves that are invested with low risk in interest-bearing assets will naturally benefit. After all, if you think that JPMorgan Chase & Co. (JPM) or Bank of America will pass on a one-for-one increase in rates to customers with deposits, you’re fooling yourself. That means more potential profit for the big financial stocks as a result of higher rates. So if you want to really take advantage of this trend, considering buying a bank ETF like XLF instead of simply hoping for better yield in your savings account.
Current yield: 1.4 percent
iShares U.S. Insurance ETF (IAK)
Banks have a bunch of ways to make profits — including loans and risky trading desks — so many investors may not want exposure to financials just to play higher rates. An interesting twist, then, is to play insurance companies that take in cash premiums but park the money in interest-bearing assets until the need for payments arise. In a low interest rate environment, insurers like Metlife (MET) and Prudential Financial (PRU) haven’t made much on the “float” between when customers pay their bills and when a claim is paid. But with higher rates, that cash reserve will generate much better returns for these picks and others that make up IAK.
Current yield: 1.4 percent
ProShares Equities for Rising Rates ETF (EQRR)
This is a unique and hand-picked fund that focuses on individual stocks that stand to benefit most from higher interest rates based on how they do business. Sure, its top holdings includes banks and insurers, but also well-capitalized companies that may benefit from their financial activities. A great example is Caterpillar (CAT), which has a robust corporate finance department for clients buying its costly machinery. Only about 27 percent of the fund is in financials as a result, which could give you a bit more diversification if you’re not looking to go all-in on a sector fund to play interest rates.
Current yield: 1.3 percent
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7 ETFs to Buy as Interest Rates Rise originally appeared on usnews.com
